SB 1040 has been passed, and like most bills of its kind it is long and complicated but can be made simple to understand for those affected by it.
I want to do two things today:
1. Help teachers with the rather important decision they need to make in the next month.
2. Apply what’s happened to teachers’ retirement to the rest of us.
I’ll do this in reverse order.
2. Application Points:
~ The government, corporations, money managers, and even you for that matter cannot predict the future. Pension programs are essentially promises based on assumptions about the future. What is happening now to the teachers’ pension fund was bound to happen. Changes in population, federal government funding, competition to public education are just a few of the many contributing reasons why today’s pension cannot keep yesterday’s promises.
~ Free Markets work. Small committees making long-term planning decisions have never worked.
~ Let me say this another way: There is not one example of a government or small, centralized committee that was able to meet a long-term projection. On the other hand, the market has created thousands of millionaires, exceeding the expectations of disciplined and prudent investors.
~ The four options teachers are being given by the pension administrators is a false-choice dilemma. The real choice is this: Do you trust your Pension System to give you the best results or do you trust the Market?
1. The Decision:
What has happened to the average teacher’s pension? What is the choice they have to make?
I’ve evaluated a dozen of these cases in the short time since the bill detail came out. The following is an example of one of these cases…
35-year-old teacher who has 15 years left until she gets full retirement. She started teaching at age 25 and then purchased five years using her own funds. At age 50 she will have worked for 25 years; add in the 5 years she bought, and she will have 30 years in and can retire with full pension.
Her pension has been estimated at roughly $40,000 per year. This is the amount of pension that this teacher has been planning for. This was a part of her employment contract for the past 10 years.
Based on SB 1040, unless she adds more of her funds to the program, her new pension is estimated at roughly $23,000. $17,000 less than promised. This, by the way, is “option 4” (out of four total options) on the forms.
If she wants to keep her entire pension, she will need to deposit $5000 of her income annually to fund the pension program, or over $400 per month, roughly $200 per paycheck.
If she would otherwise save this $5000 into a self-directed IRA account and achieve 8% from the diversified market, then in addition to the reduced pension of $23,000 she would have $146,000 in her IRA at age 50.
Important Question: Can $146,000 produce $17,000 of life-time income to a 50-year-old to bridge the gap left by the pension? The answer is No, but consider the following:
This teacher will not fully retire at age 50. She will either continue working past age 50 or will take her reduced pension and work elsewhere. She does not foresee needing the $146,000 investment funds until she turns 60…10 years later.
Assuming she adds nothing to the IRA from age 50 to 60 (and with the same 8% return assumption) her IRA balance at age 60 would be $316,000.
Three Important Questions:
1. How much life-time income can $316,000 of invested assets produce? Answer – assuming a 6% annual withdrawl – $19,000 per year.
2. What happens to a pension check when the pension recipiant dies? Answer – it stops.
3. What happens to an IRA balance when the owner of that IRA dies? Answer – it goes to that person’s beneficiaries.
All things considered, my advice is this: Give as little money as possible to the pension system and save as much as possible into your own IRA.